Backwardation
When the future is cheaper than the present, someone wants out now, or something is scarce now. Either way the curve has inverted.
In short: backwardation is the state of a futures curve in which prices fall with time to expiry: the future trades below spot and later months below nearer ones. In commodities it arises when the physical good is scarce today. In equity index futures, where the carry is normally positive, it arises from heavy selling or hedging in futures, or from a cluster of dividends before expiry. A long position in backwardation earns the carry at each roll instead of paying it.
The intuition
Contango is what the arithmetic of interest and dividends produces when nobody is in a hurry. Backwardation is what the market produces when somebody is. In a commodity, a refinery that needs crude this week pays more for delivery now than for delivery in three months, and the curve slopes down. In an equity index, there is no shortage of “the Nifty”, so a discount cannot come from scarcity. It comes from the other side: participants selling futures faster than arbitrageurs can absorb, usually to hedge a cash portfolio or to express a bearish view with leverage, or from dividends that will be paid before expiry and that the futures buyer will not receive.
A sustained index discount is uncommon on NSE because arbitrage desks can buy the cheap future and sell the basket. It is the brief discounts, on sharp down days or into an event, that carry the information.
Formula
Curve is in backwardation when Ffar < Fnear < spot
Fair price = spot × e(r − q) × T; a discount below fair value by more than the dividend effect is the hedging or selling premium
Roll yield for a long = (Fnear − Ffar) × lot size, positive in backwardation
Worked example (illustrative numbers)
Suppose NIFTY is at 24,000 with 30 days to expiry and fair basis of about 105 points. On a day of heavy foreign selling the near-month future trades at 23,950, a 50-point discount, and the next month at 23,990.
| Level | Price | Versus spot | Versus fair value |
|---|---|---|---|
| Spot | 24,000 | ||
| Near month (fair 24,105) | 23,950 | −50 | −155 |
| Next month (fair 24,203) | 23,990 | −10 | −213 |
The discount against spot is 50 points, but the discount against fair value is 155 points, about 0.65% of notional for a one-month contract, or roughly 8% annualised. That is the premium hedgers are paying to be short. A trader long one lot (65 units) who rolls near to next month here pays only 40 points, ₹2,600, instead of the fair 98; a short who rolls receives the same. The curve has inverted in annualised terms even though both months are still slightly below spot rather than above it.
Why it matters to an options trader
- Options reprice off the discounted forward. Puts at a given distance from spot become dearer than calls when the future is at a discount; the skew reading should be taken against the future.
- It is a fear reading in points. A discount that widens as the index falls shows hedgers chasing protection; a discount that narrows on a down day shows the selling is exhausted.
- Short rolls are paid, long rolls are cheap. Writers of synthetic shorts and futures shorts collect the carry in backwardation; it is the only time a long roll is nearly free on NSE.
- Commodity options live with it. MCX crude and natural gas curves are often backwardated; a far-month call on crude can be far out of the money in forward terms while looking at the money against spot.
Common mistakes
- Measuring the discount against spot only. The informative gap is against fair value, which includes the carry the future should have had.
- Reading every discount as bearish. A large dividend before expiry lowers fair value; stock futures routinely trade below spot in dividend season with no selling pressure.
- Buying the discount blindly. A discount is cheap carry, not a reversal indicator; it has persisted through entire declines.
- Confusing index and commodity causes. Index backwardation is positioning or dividends; commodity backwardation is physical scarcity, and the two behave differently as expiry nears.
Indian-market specifics
- NSE index futures (Nifty, Bank Nifty, FinNifty, Midcap Select) trade at a premium to spot in normal conditions because Indian funding rates exceed the dividend yield; discounts occur on heavy-selling days, around events, and in months with dividend clusters, and the final settlement at the underlying’s closing value forces the gap to zero on the last Tuesday.
- Stock futures show dividend-driven backwardation more often; NSE adjusts contracts only for extraordinary dividends above its threshold, so ordinary dividends reduce the fair futures price directly.
- On MCX, crude oil and natural gas futures mirror international curves and are frequently backwardated during supply tightness; gold and silver, carried on financing and storage, rarely are.
- The month-to-month spread can be traded as one spread order on NSE, which is how a long in backwardation captures the roll yield without legging risk.
FAQ
What causes backwardation in Nifty futures?
Hedging or selling pressure, or dividends before expiry.
Is backwardation bullish or bearish?
It shows bearish positioning, not a direction forecast.
What happens to a long futures position in backwardation?
Rolling is cheap or paid; longs earn roll yield.
How is backwardation measured against fair value?
Fair value minus actual; 155 points in the example.
See whether the future is at a discount today
The futures page shows the premium or discount of Nifty and Bank Nifty futures from the latest session, and the commodities pages cover the MCX curves. In the app, the FII/DII page and Smart Money read the positioning behind a discount.
Related terms
- Contango, the normal index state
- Basis, the gap at one expiry
- Cost of Carry, what fair value is built from
- Rollover, where the discount pays off